ACCA FM · Guided practice (Show me how)
Chapter 20: Capital asset pricing model
CAPM - required return, beta and a project at its own rate
Three companies from the notes. All are financed entirely by equity. The capital asset pricing model: E(ri) = Rf + beta i (E(rm) - Rf).
(a) Q plc has a beta of 1.5. The market is giving a return of 12% and the risk-free rate is 5%.
(b) S plc is giving a return of 20%. The stock exchange as a whole is giving a return of 25%, and the return on government securities is 8%.
(c) T plc is all equity financed. It wishes to invest in a project with an estimated beta of 1.4, which is significantly different from the business risk characteristics of T's current operations. The project requires an outlay of $100,000 and is expected to generate returns of $15,000 p.a. in perpetuity. The market return is 11% and the risk-free rate is 6%.
(a) Q plc: required return
Calculate Q plc's required return.
(b) S plc: beta from returns
Calculate S plc's equity beta.
(c) T plc: a project at its own CAPM rate
Calculate T plc's required project return and net present value, and state whether the project should be accepted.
Opening this exercise…